What are the different types of life insurance
According to LIMRA, one of the largest trade associations in the U.S. insurance industry, the most common reasons for buying life insurance are to pay for burial and other end-of-life expenses, supplementing lost income if the primary wage earner dies, and transferring wealth from one generation to the next. Around 52% of Americans buy it themselves or through an employer. Understanding the different types of life insurance can make it easier to decide if you want to buy a policy.
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- The fundamentals of life insurance
- The different types of life insurance
- What are the benefits of life insurance?
- Can I withdraw money from my life insurance policy?
- What happens if I stop paying my life insurance bill?
- What isn’t covered by life insurance?
- What disqualifies you from life insurance?
- Can I reapply if I’m turned down?
- In a nutshell
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The fundamentals of life insurance
Life insurance is a contract between a policyholder and an insurer. The policyholder pays premiums during their lifetime in exchange for the insurer promising to pay a designated beneficiary a sum of money when the insured person dies.
The first American life insurance companies started during the colonial period. In 1759, the Corporation for Relief of Poor and Distressed Widows and Children of Presbyterian Ministers was set up. Episcopalian ministers started a similar fund in 1769.
Life insurance sales began to increase by the end of the 1850s, just before the Civil War started. Sales climbed to $200 million by 1862 and tripled to just under $600 million by the end of the Civil War. In 2021, life insurance premiums surpassed $159 billion, according to the National Association of Insurance Commissioners.
The different types of life insurance
Life insurance is offered in different forms to meet different needs and wants. The most popular and cheapest type — term life insurance — is temporary and a set length of time. You could outlive a term life policy.
The other kinds we’ll cover are permanent life insurance policies. They cover the insured person’s entire life unless the insured stops paying the premiums. Permanent policies are usually more expensive than term.
Term life insurance
Term life insurance is a policy bought to last a specified period of time, such as 1, 5, 10, 20, or 30 years. Coverage expires when that term ends, and payout only happens if the insured person dies during the specified period. If the insured outlives the original policy period, the policy may be able to be renewed, though premiums may be higher.
The death benefit is to replace income that may have been earned during the set period and is needed to cover expenses. These can be everything from daily living expenses for a surviving spouse, making sure a child is taken care of, or paying off a large debt such as a mortgage.
The different types of term life are:
- Level term: Death benefit stays the same throughout the policy.
- Decreasing term: Potential death benefits reduced over life of policy, usually in one-year increments. The policy is renewable.
- Renewable term: Price quote is for the year policy is purchased. Premiums increase annually.
- Convertible term: Term policy can be converted to permanent insurance.
Whole life insurance
Whole life insurance is a type of permanent life that accumulates cash value. It covers the insured’s entire life, provided they keep up with premium payments.
Cash value is money that the insurance company has collected in premiums that exceed what it needs to pay out claims. Policyholders can withdraw or take out a loan against the accumulated cash value.
Cash value is a living benefit; the insurance company keeps these funds when the insured dies. Loans against the cash value may reduce the death benefit.
Universal life insurance
Universal Life (UL) is another type of permanent life insurance. It has cash value that earns interest.
Premiums are flexible and can be adjusted over time. They can be set with a level death benefit or an increasing one.
Variable universal life insurance
Variable universal is a type of permanent life insurance that lets you invest the cash value in a separate account or accounts, similar to mutual funds. Like universal life, it has flexible premiums that can be set with a level death benefit or an increasing one.
Final expense life insurance
Final expense is a type of whole life insurance that is permanent. It usually has a lower payout amount than other types of life insurance. Most life insurance policies focus on income replacement, while final expense insurance covers end-of-life expenses. These can include:
- Funeral arrangements
- Burial costs
- Remaining medical expenses
- Remaining legal expenses that your beneficiary must settle
What are the benefits of life insurance?
Life insurance replaces your income if you die. Your spouse and children can have enough money to pay off a mortgage, attend college, pay off loans, and have enough income during what would have been your working years. Term life insurance can be set until you reach retirement age to help your beneficiaries avoid financial hardship.
Life insurance also offers tax advantages, among them:
- Tax-deferred growth of cash value
- Tax-free dividends
- Tax-free death benefits
Can I withdraw money from my life insurance policy?
Yes, if you have a permanent life insurance policy. You can take out cash before you die through four main methods:
- Surrender: Cancel the policy and take the surrender value cash payment minus fees.
- Withdrawal: The money you take out as a lump sum or in payments usually isn’t subject to income taxes if it isn’t more than what you’ve paid into the policy. A withdrawal will likely reduce your death benefit.
- Loans: The money borrowed against a policy doesn’t come from the policy. The policy is used as collateral. These loans require paying interest, but it’s usually a lower rate than other types. The outstanding balance will typically be deducted from your death benefit if you don’t repay the loan.
- Pay life insurance premium: Cash value can be used to pay part or all of your policy premiums. Older policyholders may like this option because it leaves their retirement income for living expenses while keeping a life insurance policy.
If the cash value of a policy grows larger than the death benefit and you don’t use it while alive, then the higher cash value can increase the death benefit amount for your beneficiaries.
What happens if I stop paying my life insurance bill?
Your insurance company will cancel your policy, especially if it’s a term policy. You may get a 30-day grace period before your policy is canceled.
Permanent life insurance policies, however, may not automatically lapse from a missed payment. You may have three options:
- Cash out the policy, though you’d no longer have life insurance coverage.
- Agree to a reduced death benefit that no longer accumulates cash value.
- Convert to term coverage.
If you’re having financial problems and missed several payments on your insurance policy, ask your insurance provider what you can do to have it reinstated. You may be given up to five years to get current on premiums, plus paying interest.
What isn’t covered by life insurance?
Life insurance doesn’t cover everything that can kill you. Common things not covered in a policy include:
- Preexisting conditions
- Accidents while under the influence of drugs or alcohol
- Suicide
- Criminal activity
- High-risk activities leading to death, such as skydiving
- War or acts of terrorism
- Your beneficiary murders you
- Intentionally lying on life insurance application
Term life policies don’t payout if you outlive the policy’s term, such as 20 years.
What disqualifies you from life insurance?
A medical checkup is usually required to get a life insurance policy. Poor results from the exam could disqualify you, including a serious medical condition like heart disease. Nonmedical reasons that may disqualify you include:
- Bankruptcy
- Criminal record
- Positive drug test
- Dangerous hobby
- Multiple speeding tickets
Can I reapply if I’m turned down?
Yes, it will likely require fixing why you were denied coverage.
If you’re denied for a medical reason, you can try to improve your health in areas that caused the denial. Losing weight and lowering your blood pressure may be enough to get you approved the next time you apply.
Spend enough time driving safely, and those speeding tickets could be nonissues.
You can also apply for life insurance plans that don’t require a medical exam. You’ll still have to truthfully answer questions about any serious medical conditions you have, which may still lead to denial. If approved, the death payout may be small — $50,000 or so.
In a nutshell
Life insurance shouldn’t be a complicated purchase. An insurance agent can help you decide what kind and how much insurance you need. You may be able to figure it out yourself, and can avoid some confusion when talking with an agent by first knowing what types of life insurance you’re interested in.
If you have a family that depends on you, or you just want to make sure your burial expenses are covered, then you may want to buy a life insurance policy. It can help protect your family from your lost income so that they can continue living without worrying about how they will pay the bills. That may be the best benefit of life insurance: knowing your loved ones will have enough money when you’re gone.
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